Stockton closely watching San Bernardino's CalPERS case

STOCKTON - Before it's finished, Stockton's bankruptcy may grow into a mammoth fight over public employee pensions with reverberations felt throughout California and the nation.

Scott Smith

STOCKTON - Before it's finished, Stockton's bankruptcy may grow into a mammoth fight over public employee pensions with reverberations felt throughout California and the nation.

But Stockton may have the luxury of taking a back seat as the California Public Employees' Retirement System, which manages Stockton's pensions, battles to the bitter end with Wall Street creditors and bond insurers.

"This is potentially the kind of issue that will go to the U.S. Supreme Court," said attorney Michael Sweet, a partner at Fox Rothschild LLP. "CalPERS will be well represented in that fight."

Upon filing Chapter 9 this summer, Stockton charted its strategy, which leaves intact its contract with CalPERS, the nation's largest public employee retirement fund and the city's largest creditor.

The city didn't dare take on CalPERS alone in a potentially costly court battle. The city also feared that changing its compensation package, including pensions, would make it even more difficult to retain and recruit employees, such as police officers.

The city's plan drew backlash from banks and bond insurers, who stand to lose millions in Stockton's bankruptcy. While the city isn't cutting CalPERS, it chose not to pay many of the creditors.

Those creditors are challenging Stockton's right to file for bankruptcy, arguing in part that the city didn't negotiate in good faith by failing to ask CalPERS to take a hit.

The city doesn't deny that Stockton's obligation to CalPERS is significant and growing. As its largest creditor, Stockton this year paid the pension fund $16 million. The city projects that cost to nearly double by 2020 to a $30 million annual cost.

In that same span, the city's revenues are expected to grow by about 10 percent.

That rising cost paid from the city's coffers may agitate residents of Stockton and other communities, Sweet said, because there is no tangible value.

"It doesn't fill potholes, keep libraries open or put another cop on the street," he said. "It's really hard for folks to swallow."

As an indication of the coming fight, CalPERS attorney Michael Gearin in a recent hearing told U.S. Bankruptcy Judge Christopher Klein, who is overseeing Stockton's Chapter 9 case, that CalPERS intended to begin filing briefs in Stockton's case alongside the city

Gearin said he wished to weigh in on the city's right to settle lawsuits outside of bankruptcy court. The first filings from CalPERS are expected by Jan. 16.

CalPERS has taken a more aggressive position in the bankruptcy of San Bernardino, which filed Chapter 9 on Aug. 1, about a month after Stockton.

Unlike Stockton, San Bernardino opted to stop paying CalPERS and has so far missed $5 million in payments since filing bankruptcy. CalPERS responded by threatening to sue the city, saying state law requires the city to pay because CalPERS is a state agency.

"The city should not be allowed to use the bankruptcy process to avoid complying with applicable law," CalPERS attorneys said in court papers.

CalPERS sued Compton for skipping some payments, causing officials there to hand-deliver a check to the CalPERS office. Compton has openly contemplated bankruptcy but has not filed.

Stockton has modeled its strategy after Vallejo's, which exited bankruptcy in 2011 never challenging CalPERS. Rather, Vallejo set the precedent by winning a battle that allowed the city to break its contracts with its labor groups.

CalPERS is sure to put up a fight in San Bernardino, said Franklin Adams, a partner at Best Best & Krieger LLP, because if San Bernardino wins in its bid to change its CalPERS contract, that will send a message to other cities.

"It becomes more enticing for a city to say, 'Maybe I do want to go to bankruptcy,' " Adams said.

He added that several retirees he knows have asked if they should be concerned with losing their pensions. He tells them: "Not right now. Don't get excited."

Dave Renison, president of the San Joaquin Taxpayers Association, said officials in Sacramento missed an opportunity earlier this year to engage seriously in pension reform that would have relieved Stockton, San Bernardino and a lot of other cities struggling to remain solvent.

San Bernardino will now become the test case for Stockton and others to watch.

"I think it's unfortunate the state Legislature didn't come together on pension reform," Renison said. "Now this issue will probably become a product of the court."